Final answer:
The distinction between a principal and an agent is crucial for revenue recognition; a principal records the gross revenue, while an agent records only the commission or fee earned.
Step-by-step explanation:
It is important to distinguish between a principal and an agent because these roles determine how revenue is recognized in a business transaction. A principal is a party that has control over the goods or services before they are provided to a customer and therefore recognizes revenue in the gross amount of consideration to which it expects to be entitled. In contrast, an agent recognizes revenue only to the extent of any fee or commission to which it expects to be entitled in exchange for arranging for the goods or services to be provided by the principal or another party.
For example, if a company sells products directly to consumers online, it acts as the principal and records the full sale amount as revenue. Conversely, if the company only facilitates sales between manufacturers and consumers, taking a commission for each transaction, it acts as the agent and records just the commission as revenue.